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Published On: Mon, Nov 19th, 2012

Technical Analysis: Trends and Breakouts

After we understand what is meant by support and resistance levels, we can move to the next most commonly used terms in technical analysis :  Trends and Breakouts.  These two terms differ from what is generally seen in support and resistance levels but can be equally valuable when looking to base trades on technical price analysis and chart behavior.

Both trending moves and breakouts are chart formations that give traders a clue about how prices are likely to travel in the future.  Both trends and breakouts are defined in terms of their directional bias (either upward or downward), so while each of these phenomena will fail in giving traders a sense of exactly how far prices are likely to travel, they can be critical in helping to determine the direction of the asset’s value, and this can help immensely when determining whether you should enter into a long position (buying) or a short position (selling) for your chosen asset.

Trading with Uptrends and Downtrends

Since trends help technical traders to get a sense of whether prices are likely to head higher or lower, identifying trends can show you where the market momentum is centered and this can help you to spot profitable positions when trading along with that underlying momentum.  Trends can be short, intermediate, or long term in nature (depending on which charting time frame is being used), and here we will show the varying characteristics of each trend direction.

Characteristics of Uptrends

If you feel that the price of an asset of likely to rise in the future, the first thing you should do is take a look at a chart and make an assessment of the overall trend.  Since you will need to see an uptrend in order to confirm your trading bias, you will need to see a structure similar to what is found in the graphic below:

What should be clear from the chart graphic above is that prices start lower than they finish and, more importantly, the overall structure is defined by a series of higher price highs along with higher price lows. These higher highs and lows (shown by the horizontal blue lines) can also be viewed as shorter term support and resistance levels.  But the key feature of these levels is that they gradually increase as time progresses.  Without this, an uptrend would not be present.

Characteristics of Downtrends

At the same time, when you feel that the price of an asset of likely to fall in the future, you should look at a chart and make an assessment of dominant trend.  Since you will need to see a downtrend in order to confirm your bearish bias, you will need to see a structure similar to what is found in the graphic below:

What should be clear from the chart graphic above is that prices start higher than they finish and that the overall structure is defined by a series of lower price highs along with lower price lows. These lower highs and lows (also shown by the horizontal blue lines) can be also defined as shorter term support and resistance levels.  But the critical feature of these levels is that they gradually decrease as time progresses (into the end of the chart space).  Without these characteristics, a downtrend would not be present and the original bearish trade should not be executed.

Spotting Breakouts

In many cases, a precursor to a trend can be seen in a breakout, which is defined as an occurrence where prices break a clearly defined support or resistance level.  The logic here is that once prices break one of these critical levels, market dynamics are shifting and prices are likely to continue in the direction of the initial breaking movement.  Here we will look at examples of upside and downside breaks.

First, an example of an upside breakout, suitable for establishing long (buying) trades:

Here, we can see prices test resistance multiple times, until market pressures push to the upside.  Once this occurs, prices carry in the upward direction, propelled by the initial momentum.  Long (buy) trades could be established at the level shown by the red arrow.

Next, we look at a visual example of a downside breakout, suitable for establishing short (selling) trades:Here, we can see prices test support multiple times, until market pressures push through to the downside.  Once this occurs, prices carry in the downward direction, propelled by the initial momentum.   Short (sell) trades could be established at the level shown by the first red arrow.

Conclusion

When looking at uptrends/downtrends and upside/downside breakouts, traders are able to identify situations where new positions can be established.  When trading with the direction of the trend or breakout, spread betters will have an added advantage (a higher probability for gains), as the market momentum is likely to continue in the original direction of the price formation.

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About the Author

- Marcus Holland has been trading the financial markets since 2007 with a particular focus on soft commodities. He graduated in 2004 from the University of Plymouth with a BA (Hons) in Business and Finance.

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